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JOHN KING, HOST: I'm John King, and this is our "State of the Union" report for this Sunday, March 22nd.

President Obama responds to the AIG scandal saying the buck stops with him, and an outside review sees more red ink in the administration's plan to pay for its ambitious agenda. We will discuss the outrage and check the math with one of the president's top economic advisers, Christina Romer.

A Republican who not long thought so highly of the new economic team he agreed to join the Cabinet, now compares the Obama administration's approach to Venezuela. The Senate Budget Committee's top Republican, Judd Gregg, explains his changing tune.

And three and a half years after Hurricane Katrina, a new normal settles in New Orleans. We'll visit one neighborhood that is trailing far behind the city's recovery. That's all ahead in this hour of "State of the Union."

Live pictures of the White House there on a beautiful Sunday here in the nation's capital. And the wait is almost over. The Obama administration this week will share its plan to ease the credit crunch and put more money in your hands. The goal is to rid struggling banks of the toxic loans that keep them from lending. One question is how Wall Street, which posted its first two-week gain in nearly a year, will take the news. And the announcement follows a week of outrage over millions in bonuses handed out by insurance giant AIG, even though it is taking billions in taxpayer bailout funds.

Let's talk it through with the president's chief economist, chair of the White House Council of Economic Advisers, Dr. Christina Romer. Welcome to "State of the Union."

ROMER: Great to be here.

KING: Let's start with the toxic asset plan. Here it is on the front page of the Washington Post. "Treasury Presses Ahead with Plan for Toxic Assets." The announcement tomorrow. A couple of sentences in this account troubled me, and I'll start with this one here. "But the government will put far more money into the deals and take on more risk than the investors, which could include hedge funds and foreign investors."

So taxpayers, who are already bailing out financial institutions, already outraged over bonuses at AIG, are going to take on more risks here? ROMER: I think you need to keep your eye on why we're doing this at all, which is we do know that banks have these so-called toxic assets on their balance sheets. We think they're highly uncertain. They are making banks unwilling to lend, they're making private investors unwilling to come into banks. We need to get those off the banks' balance sheets. That's a market that really hasn't been functioning, really hasn't existed. That's exactly when the government needs to step in.

And what is really innovative about this is partnering with private investors, partnering with the FDIC and the Federal Reserve to get all the resources we can to get those things off banks' balance sheets.

KING: One other thing in this front page account in the Post, key details of the toxic asset purchasing program are not yet finalized. Treasury officials express concern the markets would expect too much.

You remember when your colleague, Secretary Geithner, gave the broad outlines of this plan. It was so vague, the markets tanked. Are you sure you will meet the test this time?

ROMER: I think it is important to realize this is just one piece of what we're doing. So if you think about what his speech in February is supposed to be, that was the broad outline, and what we've been doing sort of each week since then is rolling out the housing plan, the small-business plan, the consumer and business lending initiative. This is just one more of those pieces, and I don't think Wall Street is expecting the silver bullet. This is one more piece. It's a crucial piece to get those toxic assets off, but it is -- it is just part of it, and there will be more to come.

KING: There are many critics of the administration who are critical just about every day, who don't like the way this is going forward. But I want you to respond to a critic from someone who is like-minded. Paul Krugman in the New York Times, an economist who generally supports the administration's perspective, says this of your plan. "This plan will produce big gains for banks that didn't actually need any help. What an awful mess."

ROMER: I think that's just unfair. And again, keep in mind why we're doing this, it's precisely because banks have these bad things on their books. We need to get them off. We think this is a good way.

Another way to say it, part of the reason we're partnering with private investors is to make sure the government doesn't overpay, right, so it isn't just another handout to banks, right? We are trying to actually help the taxpayer by using the expertise of the market to set the price for these toxic or legacy assets.

KING: Is there a number at which taxpayers are at risk in terms of loan guarantees or programs guarantees, a monetary figure you can put on this? ROMER: I think, you know, the Treasury, I think we're putting up something in the order of $100 billion, out of the TARP funds, working through, again, the FED, the FDIC.

You know, the crucial thing is it's being designed precisely so that it is going to be safe. We very much have the taxpayers' interest in mind, but we also have the interest of the whole economy on the mind. Right? The crucial thing is getting lending going again. I can't say that enough, and that is why we're doing this.

KING: I want to move on to the cover of Time magazine this week, and this I assume is not why you took this job and why you came to Washington. But the bailout bomb, the outrage over AIG. And the outrage is so big in the country that the Congress decided -- the House spent most of last week on a plan to punitive taxes on those executives who took the big bonuses from AIG. The Senate now will continue that debate, and wants to expand it even further to say maybe there's Fannie Mae or Freddie Mac executives out there who got bonuses. That anybody who makes a sizable amount of money who is getting a bonus from a firm that gets taxpayer money will be taxed punitively. The administration thinks that's a bad idea. Why?

ROMER: I think the main thing the president said is he very much wants to draw a distinction between the firms that have gotten a lot of government money, where the -- basically if it weren't for the government, they wouldn't still exist. He think it's completely appropriate to have different standards for them, and for firms that are basically playing by the rules and not taking a lot of money from the government.

I think the other thing to say is the president -- I mean, he shares the outrage. We all agree that a firm like AIG that is getting huge amounts of government money should not be paying bonuses, right? That's just -- that's just terrible.

What he has been trying to say, though, is let's channel this, and I think that is exactly right, to say let's make sure this never happens again. And that's why he is already talking to Congress about getting resolution authority so that the next time we have an AIG, there is a judge that can say this contract is out of here, right? We, you know, a legal way to break these contracts and go forward.

KING: You say the president shares the outrage and wants to channel it in the right way. I want to go back through the past week, because I think it's important and I think there were some mixed messages to the American people. A week ago on a Sunday show, one of your colleagues, Larry Summers, another of the president's top advisers, was asked about these bonuses and said I don't like them, but contracts are contracts, and we can't abrogate the contracts. The very next day, the president, starting to get a sense of the outrage in the country, said something quite different. Let's listen.

(BEGIN VIDEO CLIP)

PRESIDENT BARACK OBAMA: I've asked Secretary Geithner to use that leverage and pursue every single legal avenue to block these bonuses and make the American taxpayers whole.

(END VIDEO CLIP)

KING: The president makes that statement, but we learn that there is actually specific language in the Obama stimulus plan protecting these bonuses. So the reporters are trying to find out where did this language come from. One of the people blamed for this is Chris Dodd. He's the chairman of the Senate Banking Committee. He went on our air last week and said flatly, no, I had nothing to do with it, absolutely nothing to do with it, I don't know where this language came from. The very next day, when confronted with CNN reporting, he came back on our air again and said something very different.

(BEGIN VIDEO CLIP)

SEN. CHRISTOPHER J. DODD, D-CONN.: The alternative was losing, in my view, the entire section on executive excessive compensation. Given the choice -- this is not an uncommon occurrence here -- I agreed to a modification in the legislation, reluctantly.

(END VIDEO CLIP)

KING: Dr. Romer, he says he reluctantly agreed because of pressure from senior Treasury Department officials. So the president on the one hand is expressing outrage at these bonuses, but the chairman of the Banking Committee says the language that protected those bonuses was put in the bill by the Obama administration. Is that Washington double speak, or was the president ill-served by his own economic team?

ROMER: You know, I think the truth is, I don't really know all of the tick-tock of when various things were done. And I'm not sure it's useful. I think the president, again, is very -- very aware of, you know, just how outrageous these things are. He has expressed it. That is his genuine...

KING: But if they're so outrageous, why did the Treasury Department put language in the stimulus plan that protected them?

ROMER: I think there, again, there were legal issues, and I can't really help you about sort of the particulars.

I think the thing I want to keep coming back to is the big picture. The president absolutely says there's just this crucial distinction, firms that are getting a lot of government money -- absolutely, we need a different way to deal with those so that this kind of thing doesn't happen, because it is, frankly, outrageous.

KING: Mr. Liddy, the AIG CEO, was in the hot seat in Congress this week, and they beat him up pretty good, trying to blame him for this. He is a former Allstate executive, who came in to do this. He's being paid I think a dollar a year. Rate him. How is he doing? I know everyone is outraged about these bonuses, but he says, just as the administration says, we inherited this mess. He says they were already on the books. How is he doing? The government owns, essentially owns 80 percent of this company right now. How is he doing?

ROMER: I think the president did I think very much want to make a distinction, that he was not the person that had gotten us into this mess and was not -- you know, was the person that was trying to help us out of it. Again, I don't think it's useful for me to be rating or second- guessing. I think, you know, the big issue, this is a company that, you know, should never have gotten as big and as systemically important as it was. I mean, that's why, I think, going forward, certainly, one of the things we will be talking about at the G-20 is financial regulatory reform, precisely how do we make sure this doesn't happen again, that we get firms like this that can be so important to the economy that we can't let them go down, and yet they can do these outrageous things.

KING: You mentioned it got so big, and that is the problem.

I was down in New Orleans this past week. One of the things I did was stop by a class at Tulane University. The former speaker of the House, Newt Gingrich, was there, speaking to a class that is taught by our colleague here at CNN, the Democratic consultant James Carville. And he hit the point you just made about things getting too big. I want you to listen to the former speaker of the House, Newt Gingrich.

(BEGIN VIDEO CLIP)

NEWT GINGRICH, FORMER SPEAKER OF THE HOUSE: One of my conclusions over the last 10 years is, if you are too big to fail, you're too big to manage. And I would break up Fannie Mae, I'd break up Freddie Mac. I would break up AIG. I frankly wouldn't defend any of the biggest banks. And I say, if you're too big to be managed, you need to become smaller.

(END VIDEO CLIP)

KING: Is Newt Gingrich right?

ROMER: He is getting at an idea -- certainly, we know we need a financial regulatory structure that puts limits on these companies, or if you are going to be too big to fail, we've got to have an eye on you and make sure that you're taking prudent practices.

KING: Mr. Liddy said he is going to break up AIG. Do we need to break up Fannie and Freddie?

ROMER: I think that is certainly going to be an issue going forward. I think it should be part of the overall financial regulatory reform, to figure out what is the best way.

Again, you know, anytime we have now got taxpayer money on the line, what we have an obligation to do is do it in a way that protects the American taxpayer. What is going to be the way that gets these institutions safe, gets them doing what we need them to do, which is lend like crazy, and just basically functioning again for the economy.

KING: More of our conversation with Dr. Romer in just a minute. Paying for his plans to overhaul health care and education already was a daunting challenge. Now, a new estimate suggests deficit spending in the Obama administration could dwarf the record red ink of the George W. Bush presidency. Will the president have to scale back his plans or maybe raise more taxes? Coming up.

(COMMERCIAL BREAK)

(BEGIN VIDEO CLIP)

REP. JOHN M. SPRATT JR., D-S.C.: Can we get everything done in one year? I doubt it. But we're behind him, and we think the country is behind him to give him the mandate that he earned in the last election.

(END VIDEO CLIP)

KING: The House Budget Committee Chairman John Spratt there.

We continue our discussion now with the chair of the White House Council of Economic Advisers, Dr. Christina Romer. An ally in Congress, John Spratt, saying I doubt it, I doubt it. The question is can you pass all of the president's ambitious agenda this first year.

The reason he says he doubts is because of these new numbers I want to show on the wall. The Congressional Budget Office has a more pessimistic view of the economy than you do at the White House. They say growth next year will be 2.9 percent. The administration says it will be over 3 percent, 3.2 percent. The administration says the unemployment rate will go down to 7.9 percent. The Congressional Budget Office thinks it will actually keep going up to 9.0 percent. And if you look at the federal budget deficit, the administration says about $1.17 trillion with a "t," CBO says $1.38 trillion.

Now, these aren't just numbers. This is your ability to pay for health care, your ability to pay for the president's education agenda, or the tough choices you would have to make, whether to pare something back like health care, which the president promised in his first year, or go looking for other revenues out there, to raise taxes.

What will the tough choices be if CBO is right?

ROMER: I think there are a couple of things to say. One is, there is a question whether CBO is right. So we know that forecasts, both of what the economy is going to do and of what the budget deficit are going to do are highly uncertain. And especially when you get further out in the CBO numbers, we think they really are too pessimistic in thinking about how fast the U.S. economy can grow even in normal times and more pessimistic than most private forecasters or the Federal Reserve. So there is that issue.

On the trimming back, I mean, I think the president is in complete agreement with the CBO on a crucial issue, which is the deficit is way too big and he is committed to getting it down. He -- that commitment to cut the deficit that we inherited in half absolutely stands, and we will work with Congress to make the hard choices to do that.

Let me pick up on health care, though, right? That is a crucial issue, one that the president said we just can't put off. But that's an issue where I think, again, we agree with the Congressional Budget Office. They have been saying for the last probably 10 years that the thing that's going to bankrupt the federal government is the rising cost of health care, and that is why the president has said we can't take that off, right? That is such an important issue. We haven't dealt with it in good times and bad times, and peace time and wartime. When are we going to deal with it? He said now is the time.

KING: Is it so important that if the economy does not rebound as fast as you think and as fast as you hope, that it is so important of doing it now that you would take the politically more risky decisions, like taxing the health insurance benefits I receive from my employer, that others receive from their employer, or going out somewhere else to find revenue, find tax increases to do it now, as opposed to saying let's wait a year or two and let the economy come back, where it might be more affordable?

ROMER: I think the key thing -- again, think of what we are trying to do on health care. A big part of that is cost containment, figuring out why it's rising at so much -- why health care costs are rising at a so much faster rate than GDP is growing, or other costs are going up. And that is just going to be crucial. Those are absolutely...

KING: It's not enough. It's not enough. You still need revenue. In the campaign, the president said that revenue would come from the Bush tax cuts, repealing the Bush tax cuts. Instead, that money now goes to deficit reduction, and the administration wants to limit charitable contributions for wealthy Americans to get the money for health care. So even with cost containment in your budget, if your cost containment numbers are dead on in this budget, you still need revenues. If the economy does not come back at the pace you think do you say, Mr. President, we need to wait a year or two for health care, or do you find more revenue?

ROMER: You either say you need more revenues, or you need more cost containment, right? So there are things -- what he's saying is told every agency, go through your budget, the old line-by-line. But that's a real commitment to say is there spending, is there bad spending that we're doing? Let's get rid of that.

So he is absolutely committed to working with Congress to figuring out how we pay for things. That is, you know, we brought ideas to the table, but we're certainly looking for ideas from Congress as well, and we're committed to working with them.

KING: We don't like on this program to use the Washington words that people out in America don't quite understand, but I'm going to put one on the table, it's reconciliation. It means you can use the Senate rules and pass big things as part of the budget, big things like health care, like energy and environment reform, with a majority, not the 60 votes it normally takes to shut off debate on a big issue. And many have said the administration, starting to sense the opposition of Republicans and some conservative Democrats to some of these proposals, will go the reconciliation route on health care reform, on other big-ticket items. You hear the grumbling already, not just from Republicans, many centrist Democrats. The chairman of the Finance Committee, the chairman of the Budget Committee say it's not the way to do it, it's not the way to make friends with Republicans, and it's not the way to deal with these big-ticket items and build public consensus.

Will you take that off the table today, the administration going the reconciliation route?

ROMER: I think the truth is, we're getting ahead of ourselves, and sort of what the ins and outs of the legislative strategy are going to be I think is not certainly my -- to use another piece of jargon, my comparative advantage.

I think the crucial thing is just to come back to these are fundamental issues, and we absolutely -- we want to work with Congress, with the committees that are already, for example, starting to talk about health care, starting to talk about energy. Work with them to make the best legislation possible, and I think, you know, we'll continue to do that.

KING: I will translate that into an option still on the table.

I'm going to get up for my final question because we've talked a lot about Washington. I want to talk about the country. Because, when you travel in the country -- excuse me; we'll get rid of these numbers -- people ask, "When is the bottom?"

And you are the president's chief economist. And one way some people judge the economy is this way, by the unemployment rate. And we can show, here, way back, 1983, we were up at 10.4 percent. You know how this plays out; 4.6 percent, a low, in 1998; now at 8.1 percent. Some say it may go to 9 percent or higher.

That's one way some people judge the economy. Another way, especially now that so many Americans are invested in 401(k)s -- we'll make this one go away -- is this way, through the Dow and through the markets.

And you see, obviously, this is 1997, the great high of more than 14,000, in 2007, and this is about where we are now, down around 7,000, 7,200.

Dr. Romer, you see all the data. It all comes into you. As an economist and academic, and now in the political environment, what is it you're looking for?

What is it, in a report, that you will circle someday and say, "We have hit the bottom?"

ROMER: All right, so I think the key thing for us -- and certainly the president has made from the beginning, right, what he cares about is employment, getting people back to work. And so we will not be -- be satisfied or sure that we've turned the corner until we start seeing the economy add jobs rather than lose jobs, right?

So that's going to be the gold standard. But, obviously, you're going to get signals before, right? So you'll start seeing -- you know, maybe we're starting to see some glimmers. We've seen the retail sales data come in positive. We've seen some positive business -- you know, building permit data come in.

You know, a lot of the private forecasters are saying, well, maybe we're starting to bottom out, at least on the consumer side, right? So, you know, we're going to watch all of those numbers. I think the one thing we're trying to do is to keep our heads here, and to say, until we have, sort of, overwhelming evidence that we have, you know, the -- all the crucial sectors are turning up, we're not -- not going to say anything.

KING: Do you have any doubt at all that we will be on a path to growth in this year?

ROMER: I don't. I think the reason that -- I mean, I should say things could change, right? I'm not a fortune teller. I do feel strongly we've taken the right policies, the big bold fiscal stimulus, the financial rescue. As you talked about, there's going to be more announced this week.

What we're doing in housing; all of that for small businesses -- I think all of that is absolutely crucial.

And the reason we took them is we think they are the policies that the economy needs. And then we just saw the very aggressive action that the Federal Reserve has been taking.

So I think we are absolutely taking the right policies. I have every expectation, as do private forecasters, that we will bottom out this year and actually be growing again by the end of the year.

KING: Christina Romer, the chair of the Council of Economic Advisers, thanks for joining us this morning on "State of the Union."

And the debate over whether to punish those who accepted AIG bonuses heads now to the Senate, where not everyone thinks Congress is properly channeling its outrage.

Ahead, the Republican who almost joined President Obama's Cabinet and is now one of his economic plan's toughest critics, Senator Judd Gregg, joins us next.

(COMMERCIAL BREAK)

KING: I'm John King, and this is "State of the Union." Here are stories breaking this Sunday morning.

A deadly shootout in Oakland, California. Police say a parolee killed three officers and wounded two others, one of them critically. It all began yesterday after a routine traffic stop. The suspect, a parolee wanted by police, was also killed.

People in North Dakota are preparing for possibly record flooding. In the next few days, the Red River is expected to crest at 22 feet above flood stage. Officials have called in the National Guard and volunteers are scrambling to fill sandbags.

About a million Angolans turned out today for a mass today with Pope Benedict XVI. It was the pontiff's last major event in his week- long trip to Africa. That and much more, ahead on "State of the Union." An image, there, of the old mills of Manchester, New Hampshire, up in New England, this morning.

It was just weeks ago that Republican Judd Gregg was eager to join the Obama economic team. But then came a dramatic reversal, and since deciding against joining the Democratic administration as commerce secretary, Senator Gregg has emerged as one of the president's toughest critics.

And his voice matters. He's the senior Republican on the Senate Budget Committee, where there is bipartisan talk that Mr. Obama needs to scale back his ambitious spending plans.

Senator Gregg is back home in New Hampshire this weekend, and he joins us from Manchester.

Senator, good to see you on "State of the Union."

GREGG: Thank you for having me on, John.

KING: Let me start with the AIG bonus debate. You know what happened in the House last week, a punitive tax on those who accepted those bonus. The debate now moves to the Senate, where some say, let's make it even broader; let's look at people at Fannie and Freddie who accepted these bonuses.

You think this is a bad idea. Why?

GREGG: Absolutely. It's an abuse of the tax law. You know, the taxing authority of the United States is our most powerful weapon. You know, the reason we separated from England was because the British were using it abusively.

And we, as a Congress, in reaction to something that is outrageous, the AIG bonuses, should not adulterate the system of taxation in this country. We shouldn't use it in a penal and personal way. It's really overstepping the appropriate use of taxing authority -- and it leads to a very slippery slope. I mean, where does that stop?

When does the -- what happens if the that majority becomes upset with somebody else in the community of our nation and decides to tax them punitively?

And what happens to the ability of the government to go out and get participants in this financial effort to stabilize the financial system? It's going to be very hard, I suspect, to get the private sector to participate with the government if the members of the private sector fear that, by joining with the government and trying to stabilize the financial system they are going to end up with potentially a personal and a punitive tax.

It's really an abuse of the power by the Congress, in my opinion, to use the taxing authority in this way. There are other ways to get these -- get back on the issue of how you recover these bonuses. I'm sure using the legal authority that we have, rather than this excessive weapon of the tax authority.

KING: I want to show you one of the front pages of your morning newspapers in New Hampshire, the Valley News, here" "AIG Outrage Testing Obama."

And I show you this headline, Senator, because I want to ask the question, you know, as we were all covering this story last week, at the beginning of the week, the president says he is outraged; he wants to do something about it. Then, by the end of the week, we learn that the language protecting those bonuses was put in the stimulus bill at the insistence of the Obama Treasury Department.

Is that double-speak, or what word would you use for that?

GREGG: Well, we don't know who did what to whom. And hopefully we'll find that out. And I know you, as a good investigative reporter, and your team will probably get to the bottom of this.

Clearly, something happened that wasn't a good decision, which was that they did not discipline the AIG bonus structure.

GREGG: And they had the authority at Treasury to do that, both administrations had that authority, but more the issue really arises in the last few weeks. And so something should have happened, and it didn't happen. And these bonuses were paid.

People are disgusted and outraged, as they should be. But let's not overreact in a way that basically has the Congress grabbing its pitchforks, and charging up the hill, and abusing what is a core authority of a government, which is the authority to tax its people.

KING: Let me switch from pitchforks to baseball bats. When President Obama announced his economic team just after the election, you said this of Larry Summers and Tim Geithner, now a top economic adviser and the treasury secretary. You said, "He's basically signed up Manny Ramirez and David Ortiz. They're extraordinarily strong nominees."

As a fellow Red Sox fan, that's the gold standard, although sometimes Manny being Manny can get in the way. But...

GREGG: Yes, we traded him.

KING: ... Manny Ramirez and David Ortiz, do you still feel that way? And do you think Tim Geithner -- there are some Republicans, your fellow Republicans say it's time for him to go. Do you agree?

GREGG: No, no. I -- I do think that, in the area of trying to stabilize the financial sector of our economy, they're doing the right things. They haven't done it as definitively as they should have, clearly. We would have liked a plan that was more definitive earlier, but they are moving in the right direction, and the Fed is moving in the right direction.

You've got to remember, we're not going to get out of this recession unless we have credit available to the American people at a reasonable price and reasonably -- reasonably easily available. And you can't have that unless you have a financial system that's working.

And so we've had to make these really difficult, but significant efforts to try to get the financial system stabilized. And they've gone down the right route in that area.

So I -- I don't have any problem with the initiatives they've pursued in this area. I do have problems with the budget. I do have problems with the stimulus package. But in the area of defending the financial structure and trying to get it stabilized, I think they're taking the right course of action. We should have been more definitive, more specific earlier, but they're on the right course.

KING: Let's move to the budget and your concerns. You just heard Dr. Romer, the chair of the Council of Economic Advisers, she's not ready to give yet, but I know on your committee, the Budget Committee, you look at these new congressional projections and say, "Sorry, Mr. President, the math doesn't add up." What does the president have to give from his agenda, whether it be health care, education, the environment, what has to give to meet your bottom line?

GREGG: Well, first, I think your listeners have to understand how staggering the numbers are. We're talking about a deficit in the trillion-dollar range for as far as the eye can see. We're talking about deficits which are 4 percent to 5 percent of GDP, which is not sustainable under any form of government.

We're talking about a public debt -- this is the debt that people own of the federal government that will be around 80 percent of GDP. Historically, it's been around 40 percent of GDP in the out-years.

The practical implications of this is bankruptcy for the United States. There's no other way around it. If we maintain the proposals which are in this budget over the 10-year period that this budget covers, this country will go bankrupt. People will not buy our debt; our dollar will become devalued.

It is a very severe situation. And I find it almost unconscionable that this administration is essentially saying, well, we're just going to blithely go along on this course of action after they're getting these numbers which show that they're not -- they're not sustainable, and they know they're not sustainable.

The way I've described it, it's as if you were flying an airplane, and the gas light came on, and said you've got 15 minutes of gas left, and the pilot said, "Oh, we're not going to worry about that. We're going to fly for another two hours." Well, the plane crashes and our country will crash. And we'll pass on to our kids a country that's not affordable.

That's not fair to our kids. No generation should do this to another generation; that's what this comes down to. The president keeps talking about how he doesn't want to pass the problems onto the next generation? What he's guaranteeing here in his budget structure are problems which our children aren't going to be able to survive with. They're just basically not going to be able to pay the price of the cost of the government.

And it is primarily a spending issue. The proposal in this budget is to take federal spending up to 23 percent of gross national product and keep it there. Well, historically, gross national product spending in this country has been about 20 percent of GDP or the federal government has taken about 20 percent of gross national product.

When you take it up 3 percent, it doesn't sound like much, but it calculates into massive deficits and massive debt, where it -- the budget as proposed doubles the debt in 5 years, triples it in 10 years, and basically puts this country in an untenable position.

So we've got to go back, and we've got to reorganize. And what I've said, and what Senator Conrad has said, and what others in the Senate have been willing to say, let's go back, rethink this in a bipartisan way, let's take a look at where the real spending is, which is in the entitlement accounts, and figure out how we get them under control and get their growth rates into something we can tolerate so that we do pass on to our kids an affordable government.

KING: Senator, let me ask you lastly -- we're out of time -- but when you decided not to take the commerce secretary job and to remain in the Senate, you also said you would not seek re-election in 2010. Any second thoughts about that decision?

GREGG: No, no, no, absolutely not. Gee, you know? I do hope we can make some great strides here before my term is up in the area of bipartisan effort on entitlement reform along the lines of what Kent Conrad and I have proposed, but, no, I don't have second thoughts about that.

KING: Senator Judd Gregg joining us this morning from the beautiful city of Manchester, New Hampshire. Senator, thank you so much.

GREGG: Thank you, John.

KING: Two California town halls as part of a busy presidential road show and a joke that backfires during a groundbreaking late-night TV appearance. Two veteran White House insiders judge the Obama message machine next.

And, later, abandoned and rough. New Orleans deals with a new normal, an eye-opening look at life more than three years after Hurricane Katrina.

(COMMERCIAL BREAK)

KING: The United States Capitol there. Look at that sky on a Sunday here in Washington, a beautiful day.

Even the president joined the outrage this past week over those big AIG bonuses, and yet we learned that the language protecting those payments was made the law of the land at the insistence of his Treasury Department. An accidentally mixed message or the same, old Washington double-speak Mr. Obama promised to eliminate?

For an up-close look at the president's communication strategy and a late-night comedy slip-up, we turn to two White House insiders, the former Bush White House press secretary Dana Perino and CNN political contributor and Democratic strategist Paul Begala.

Paul, it's a Democratic president. Let me start with you this morning. This AIG outrage, the president saying, "Let's do all we can," the Congress, the House spending a week debating tax -- punitive taxes against those who accepted the bonuses. Is that the best use of government time, at a time when the president says we'll do health care this year, we'll do energy and environment this year, he has to get his budget passed?

BEGALA: Yes, because citizens won't support taxpayers' money going to an entity that they think is taking away some of that money for ill-gotten gains.

I think this is like -- not to bring up a bad experience from Dana's past in the White House -- this is like when we invaded Iraq and, after the invasion and after Saddam was toppled, the Iraqis looted the Iraqi National Museum.

Normally, who cares if you're an American, right? In fact, the secretary of defense said, hey, free people are free to do bad things. And we allowed that to happen. But, see, we had invaded their country. We were then responsible for security in that country. We took it over.

Well, we took over AIG. And when we did, we the taxpayers, we the government became responsible. And now they're looting AIG, these executives, and the government should have stepped in and stopped it. They could have, and they didn't, and this is why people are angry.

KING: Is it -- the government should have stepped in and stopped it, he says. But, again, it was the Treasury Department that asked Congress to put the language in there with the date protecting the bonuses from before.

You've tried to manage and tried to take the incoming from all of the federal agencies. So how hard is that? Do you think the president -- do you think this is double-speak? Or do you think this is a case where the White House didn't know what was going on in another agency of government? PERINO: In my experience, there's just so much going on at any one time. And when you're the one responding to demands from the public or demands from the press, it's very important, when you're asked a question, "What did you know and when did you know it?" to have all of the answers before you answer.

And it's very hard, because you want to be responsive, you want to make sure that you're answering the questions, but you never have all of the right answers at the -- at the -- at the time.

So what they ended up doing is they got out in front of themselves, answered a question. It was the wrong answer. Then we have spent an entire week talking about this.

I don't doubt that it's -- you know, it's not a bad thing this -- to talk about, what are we going to do about executive compensation in this country? In fact, President Bush first talked about it in 2007 at a speech in New York. So that's an ongoing conversation in the country. This was a little bit more serious.

But every day that we talked about AIG was another day that they weren't able to talk about why their health care reform policy makes the most sense or why their energy policy makes more sense. So, hopefully, you know, they can turn a corner, we can put away the long knives that Congress and the administration pulled out this week, and we can move forward.

KING: The -- the administration now faces a more skeptical Congress because of new deficit projections when it comes to the budget. Should the president trim his sails a bit now and say, "We'll have a less ambitious government," or should he be full-steam ahead with the risk of being, if he wants to do big-ticket items like health care, if the deficit numbers the Congress projects are right, he's going to have to find more revenue, which means more taxes?

BEGALA: Yes, I think that Dr. Romer in that earlier interview, I think she did a good job of trying to explain it. Look, this president is committed to cutting the deficit in half over time. That's as good as we can do, I think, frankly, while still making the investments we have to make to make us healthier, wealthier, stronger, right?

We can't have a sustainable economy, the president believes and most Americans believe, without doing something to expand health care coverage for more people, without doing something to get us off of Middle East oil, without doing something to make our educational system better.

So I think he's got the right balance. You know, you want to have the proper balance. But, you know, I still have a copy of a balanced budget at home from 1999, and it was the Democrats who balanced that budget. And so I think at this president inherits a some economic competence from the people he brought in with him.

KING: Well... PERINO: Can I just say something? You know, and people forget what happened, you know, at the beginning of -- of the -- of the next administration, which was, after -- after the Clinton administration, Bush comes in, and we also inherited a recession and Internet tax -- Internet bubble, but we also had 9/11, and that was expensive.

And the tax cuts helped get our country back on track. And for 52 consecutive months, we had job growth.

And one thing about the CBO numbers that just came out this week, we used to get accused every year for a communications strategy that would have rosy budget scenarios, right, rosy projections. And the Democrats always said, well, but CBO, if they complained about the Bush budget, CBO was right. Now, all of a sudden, CBO might not be right. I think that, you know, that is double-speak.

KING: Welcome to Washington. Welcome to Washington.

Let's -- let's -- let's move on. The president went on Jay Leno this past week -- no sitting president has ever gone on "The Tonight Show" -- mostly to sell his economic agenda, but he stepped in it a bit when he was trying to make a joke about bowling. Let's listen.

KING: Some of it was under his breath, but like the Special Olympics, it insulted thousands, if not more, and all the organizers of the Special Olympics, the Kennedy family, which has been involved in this, loyal Democrats. Talk about, A, the insensitivity of that and what it means and, B, the danger of going into a setting like that.

PERINO: Well, I think that there's a risk always when you go into a situation where it's a comedy. You want to -- you know, you want to be a part of it. And when you're president of the United States, things change, and your words can leave a mark, and it did in this case. But I think they handled it pretty well. I mean, they apologized right away. President Obama called the Special Olympics right away and he apologized. And, of course, I don't think he meant to offend anybody, but that is the risk you take when you go on a show like that as president.

KING: You're a funny guy. You like to be funny in politics, but should a president try to be funny? He did this once before. He had the joke about Nancy Reagan and seances and all that. Should he try to stay out of the funny business?

BEGALA: You have to be who you are. Right, he has a wry sense of humor, an ironic sense of humor, a self-deprecating sense of humor. He was trying to make light of himself. It was a mistake.

And I think Dana's right. You know, what I teach my kids is not -- the goal is not to be perfect, but when you make a mistake, be accountable. He called Tim Shriver, the guy who runs the Special Olympics, great guy, great organization. He apologized. And, boy, has he taken a hit for it. I actually think now the punishment is exceeding the crime, because he has said he's sorry and asked for forgiveness. That's all we can do.

PERINO: But there's really no room for humor anymore and self- deprecation. I remember I jokingly said -- they were talking about how young I was as press secretary and said, "Yes, I don't even know what the Cuban missile crisis was." I was joking -- of course I know what the Cuban missile crisis was -- but you'd never know it if you looked at all the blogs afterwards. It's just -- it's brutal. And so you have to use humor in appropriate, clean ways.

KING: All right. We need to call it a day for that. Paul Begala, Dana Perino, thanks so much for joining us.

And up next, the slow recovery 43 months after Hurricane Katrina. We'll take you to the Lower Ninth Ward in New Orleans where signs of recovery are side by side with painful devastation. "State of the Union" will be right back.

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KING: For our travels this week, we decided to check in on New Orleans. It's been three-and-a-half years since Hurricane Katrina. And Louisiana was the only state in the country where the unemployment rate went down last month.

But whether you see recovery or depression depends on where you look. One of the places we looked was right in here in the central city of New Orleans. And you see here, the Mississippi River comes up. It is right up in here where the canal and the levee broke in the Lower Ninth Ward.

I want to show you this diagram right here. This is the Lower Ninth Ward, the poorest of the poor neighborhoods. If it's green or yellow, that means a moderate number of the people have returned. These are households receiving mail. But look at all this red. This is where the levee broke. Nobody back in this area, still devastated.

I spent some time there in the weeks after Katrina and Rita and have been back a few times since. What we've found, all too familiar, heart-warming examples of hope mixed with heart-wrenching reminders of what was washed away.

(BEGIN VIDEOTAPE)

KING (voice-over): Care and concern for those in desperate need, this clinic a glimmer of hope, 43 months after the waters of Katrina changed everything.

(UNKNOWN): Hello (inaudible) Patricia Berry (ph) here. How may I help you?

KING: Questions remain from the routine to the desperate.

(UNKNOWN): , it's no charge.

KING: Ninety-five percent of the patients who walk in do not have health insurance, but no one is turned away. And Executive Director Alice Craft-Kerney encourages younger patients and parents to take a book or two on the way out.

CRAFT-KERNEY: Because we have such a low literacy level here in the Louisiana, not only are we 50th in health care, but we are also 50th in education. So they can come by, browse, and take whatever books they want, free of charge.

KING: The staff is cheery.

(UNKNOWN): Hey, I really enjoyed you coming in today.

KING: The clinic clean.

(UNKNOWN): We'll be calling you in a few minutes, OK?

KING: The neighborhood around it rough and still a mess. From above, concrete slabs and grass and weeds where homes once stood. And on the ground in the Lower Ninth, the construction and volunteer work is encouraging, but most of the ward remains an abandoned wasteland.

Overall, New Orleans' population is about 330,000 people, roughly 75 percent of its pre-Katrina number. And Tulane University's Richard Campanella says a city that was 70 percent African-American before the storm is about 60 percent African-American now.

CAMPANELLA: We've also seen the median household income go up from about $27,000 in the 2000 census to over $40,000 now, not because the city is doing better economically. My sense is that the post- Katrina city that we all wondered about three-and-a-half years ago, what would it look like, that we're there now, that the patterns are stabilizing, and we're in a sort of a new normal period.

KING: A new normal in which the Lower Ninth Ward trails well behind.

CAMPANELLA: No question about it. The hardest-hit neighborhood within New Orleans from the levee breach, the overtopping, and then a repeat with Rita three weeks later, the Lower Ninth Ward has the lowest return rate of New Orleans neighborhoods, and that's at 19 percent...

KING: Nineteen percent?

CAMPANELLA: ... out of a pre-Katrina 19,000. So that's about 3,600 folks living there today.

KING: The city is more affluent overall because the poorest of poor, the folks who lived here, can't afford to come back. Those who have returned live in a community with no supermarket or dry cleaner and just one school.

(on-screen): Why is it that you think your neighborhood keeps getting the short end of the stick?

CRAFT-KERNEY: Because, as my teacher used to say them that God gets -- those who have the money usually are able to keep the money. Much of it has been the lack of political will on the part of our governmental entities.

KING (voice-over): The clinic is among the community groups pushing for another school, a pharmacy, a supermarket. But its primary mission is giving good care and good cheer to those who have returned.

(UNKNOWN): You're doing really good. Now, what are we going to do about you and that smoking?

(UNKNOWN): Trying to get -- get me to stop.

(END VIDEOTAPE)

KING: An encouraging visit to that clinic. You know, as you know, one of our goals is to get out of Washington as often as we can. We've traveled from Louisiana to Vermont, Arizona to Georgia, and many states in between. So where should we go next? You can e-mail us at stateoftheunion@cnn.com. Tell us why we should visit your community.

We want to say goodbye to our international audience for this hour.

And up next, for our viewers here in the United States, there's a new interview with President Obama in the Oval Office. We'll take you behind the scenes at the top of our 10 o'clock hour.

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KING: I'm John King, and this is our "State of the Union" report for this Sunday, March 22, 2009.

Well, the deficit that's growing to over $9 trillion, will Congress have to slash President Obama's budget? The latest from White House economist Christina Romer and Senator Judd Gregg, the number-one Republican on the Budget Committee.

The rage over those bonuses at AIG keeps growing. What did the administration know and when did it know it? We'll debrief three top CNN reporters covering the story.

And paparazzi-style interviews on Capitol Hill. Should legislators be covered like Hollywood stars? Howie Kurtz talks to one congressman who was stalked, you might say, like a pin-striped Lindsay Lohan, all ahead in this hour of "State of the Union."

And time now, as we do every Sunday at this hour, to turn it over to my colleague and partner, Howie Kurtz, and his "Reliable Sources."